Not if, but when….

Talk of credit rationing may have spooked a few at the far end of the barnyard, but the reality is that the fodder is already being thinly spread. MR BANKER

By Mr Banker

My jaw dropped when I read a report that the chief economist from Goldman Sachs JBWere warned that “the process of credit-rationing would be upon us” if banks were unwilling or unable to take lending back on to their balance sheets.

The jaw-drop was induced by the use of the future tense to describe credit rationing.

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Less than two weeks before that report, a senior lender in the institutional team of a big four bank told me bonuses had been linked to a double-digit reduction in total lending. As a result:

Existing lending would not be automatically renewed except for A grade customers. B grade customers would be offered 50% of their previous lending, and C grade customers were being given notice to take their business elsewhere. (A, B and C grade is your correspondent’s own shorthand, not that bank’s official nomenclature.)

Deals that had been approved but not yet drawn down were being scrutinised very carefully. Failure to strictly comply with lending pre-conditions – which in the past might be stretched or deferred – was likely to result in the funding being withdrawn altogether for B and C grade customers.

New lending was off the table except for A grade customers, and even those might be asked to wait.

Now at this point, readers with a knowledge of economics might raise a querulous eyebrow.

“Surely BoLR,” they say, “this is just a matter of supply and demand. If the bank is able to charge more, won’t they be able to obtain all of the funding they need?”

No.

The prudential framework requires the banks to hold a minimum level of capital, based on the amount of lending, the level of security, and the level of risk. At the moment, Australian banks are way under that minimum, and they need to cut their lending significantly, or raise equity.

“A-ha” say the querulous-eyebrow-raised readers, “what’s all the fuss about – all you need to do is have a rights issue to raise equity.”

No – or more precisely; no way, José.

With bank share prices down at least 25% from their peak, the banks desperately want to avoid issuing shares now.

I asked the senior lender whether he thought the position was different at other banks. He thought not because otherwise he’d be losing customers hand over fist – and he’s not.

What does this mean?

Large real estate and infrastructure projects will suffer the biggest impact because it will be easiest for the banks to turn off the tap to these sectors. I expect to see lots of delays and deferrals.

Merger and acquisition activity will also fall because the banks won’t fund anything except short term facilities that will be cleared before balance date, so for anyone other than cash-rich buyers, takeovers will be scrip-based.

Will this trickle down to smaller businesses?

Banks will focus on the big end of town because that’s where the biggest gains are to be made. However if the squeeze continues then, absent equity raisings or a relaxation of prudential capital regime, it seems inevitable that there will eventually be some impact on lending to small and medium businesses.